Stocks Show Jerome Powell Is Still Wall Street’s Head of State
(Bloomberg) -- Hopes for a fat new package of government spending to plump the American economy looked to be a casualty of the election, with odds pointing to divided government. That left Jerome Powell the once and future king of markets, a regime stock investors are showing they can live with.
To say bulls shook off disappointment over stimulus is an understatement. While doubts about reflation took brief bites out of bank and commodity stocks this week, the rest of the market celebrated, adding about $2 trillion in value as the S&P 500 had its best week since April. As before, as always, a handful of software and internet colossi led the stampede higher, luring investors back on speculation their nosebleed valuations will survive the election.
It’s a truism of markets that bore out this week: Given the choice between a broad package of economic aid and targeted Fed liquidity support, Wall Street prefers the latter, due to its benefits for asset prices. In a week when almost everyone in the country was glued to the presidential outcome, traders kept their gaze trained on Fed Chairman Powell, who showed no sign of turning off the taps after policy makers held interest rates near zero and signaled their readiness to provide further support.
“The Fed is absolutely supportive, Jerome Powell continues to stress they got our backs, they’re going to be there,” said Chris Gaffney, president of world markets at TIAA Bank. “He is head of state for Wall Street.”
In a trading week that ended without an official victor in the 2020 presidential election, the market stats were stunning. The tech-heavy Nasdaq 100 closed 9.4% higher, its strongest weekly showing since April. That outpaced gains in the broader S&P 500, which rose 7.3% this week.
That traders would turn to the Fed in a week defined by uncertainty should be no surprise, given how heavy the central bank’s hand has been over the past decade. To gauge the impact from the Fed’s quantitative easing on the stock market, Societe Generale’s strategists led by Sophie Huynh ran a causality test and found that the S&P 500’s performance has been driven by Treasury yields 32% of the time since 2009. That’s double the frequency during the previous decade.
Without the Fed’s support, the S&P would be around 1,800 now, the firm’s model showed. The benchmark closed at 3,509 on Friday.
Now, with hopes of a multitrillion-dollar stimulus package fading after Democrats failed to secure both houses of Congress, markets are back to pinning their hopes firmly on the central bank’s largesse.
“With the divided government, fiscal policy is going to be smaller,” said Elliott Savage, portfolio manager at YCG Investments. “And given the economy has recovered further, there will either be less need for fiscal policy or less capacity to do fiscal policy. Likely monetary will be the bigger driver.”
As with any narrative to a dramatic swing in stocks, there’s a degree of back-fitting afoot. The prospect of a delayed election result and a split Congress was supposed to be poison for the eye-wateringly expensive U.S. equity market. Instead, the S&P 500 has posted a gain of more than 1% four out of the past five days.
“Instead of giving credit to a blue White House, they’re going to say, ‘At least we have the Fed on our side,’” said Jerry Braakman, chief investment officer of First American Trust, in Santa Ana, California, which manages around $2 billion. “This is more a rationalization of events and finding a way to accept this outcome.”
Shifting narratives or not, hedge funds went on a buying spree the day after the election despite a lack of clarity on the election. They snapped up U.S. stocks at the fastest pace in more than five years Wednesday, bidding up tech and health-care shares, according to data compiled by Goldman Sachs Group Inc.’s prime-brokerage unit. At Morgan Stanley, hedge funds’ stock purchases reached a five-month high.
While that may seem euphoric, there’s a reason that “don’t fight the Fed” is financial markets’ favorite axiom. The central bank’s balance sheet ballooned to $7 trillion after it stepped in to quell financial upheaval at the height of March’s turmoil. That’s pinned Treasury yields near historically low levels, helping to justify what some would term outlandish valuations in stocks. And as lawmakers remain deadlocked in negotiations over fiscal aid, Fed policy makers discussed the possibility of shifting purchases further out the yield curve at this week’s meeting.
“Frankly, Powell is the only person in the room that can do anything. It seems like everyone else is stuck in quicksand,” said Mike Bailey, director of research at FBB Capital Partners. “I don’t want to say he’s the last man standing, but he’s the only one who has the ability and willingness to act quickly.”
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